Crowdfunding Rule From SEC Means Anyone Can Be a VC

Equity crowdfunding could be an investing game-changer

Oct 24, 2013, 3:06 pm EDT | By Carla Lake, InvestorPlace Staff

Ever seen shows like Shark Tank, where small business owners pitch their idea to venture capitalists? Well, thanks to a new rule from the SEC, now you can be one of the sharks, and invest in promising young companies — without having to spend a fortune.

In a game-changing move, now non-accredited investors — that is, ordinary folks with less than $1 million in net worth — can invest in startup companies through crowdfunding. This long-overdue ruling is part of the JOBS Act and is intended to stimulate small business growth — but it could also spur young people to take an interest in investing.

Details of the SEC Crowdfunding Rule

Crowdfunding isn’t new. Over 50,000 creative projects have been funded on Kickstarter since 2009, and there are several other sites like Indiegogo and Rockethub where artists, filmmakers and musicians can appeal to the public to fund their projects a few bucks at a time in exchange for small tokens of thanks, from cards to 3D-printed animal skulls. But allowing just anyone to invest in a startup in exchange for equity? That could be a game-changer.

Under the proposed rules, any investor, over a 12-month period, could invest up to:

(1) $2,000 or 5 percent of their annual income or net worth, whichever is greater, if both their annual income and net worth are less than $100,000, or
(2) 10 percent of their annual income or net worth, whichever is greater, if either their annual income or net worth is equal to or more than $100,000. During a 12-month period, these investors would not be able to purchase more than $100,000 of securities through crowdfunding.

It’s possible that small-time investors could get burned here. In their first year, 25 % of startups fail — and the percentage only goes up with each successive year. The risk here is high — which is why only the big dogs who could afford to lose were allowed to play until now.

However, it’s not a completely awful deal for the little guy — after all, the rule caps the amount of non-accredited investor funding at $1 million per year, and if equity crowdfunding efforts allow non-accredited investors to contribute just a small amount in exchange for outsized profits, the risk-reward profile here would be more in the line with buying a lottery ticket than buying a penny stock.

Investing for the Future

But what’s really interesting is how popular crowdfunding is among millennials — the demographic most fearful of investing, since they’ve seen their parents burned in the financial crisis. According to a study of young accredited investors from iCrowd, crowdfunding appealed to young people because they are interested in alternative investments, they’re always plugged in to the Internet, and they’re more socially oriented than previous generations — that is to say, they’re all about sharing with their followers and friends on Twitter (TWTR) and Facebook (FB)…which helps crowdfunding projects to go viral.

Granted, this study only targeted youngsters who already had a high net worth. But it’s not such a far stretch to imagine that these traits hold true even for not-so-wealthy 20- and 30-somethings (read: most 20- and 30-somethings). With the limits on net worth now lifted, presumably anyone can try equity crowdfunding, whether you have $5 or $500 to invest.

Will equity crowdfunding replace traditional equity markets? It’s still in its infancy, but even if you have no plans to throw money at a startup, this is a development that you should be paying attention to as a new equity market.

Carla Lake is an assistant managing editor at Investorplace. As of this writing, she did not hold a position in any of the aforementioned securities.